Moral hazard in active asset management

David C. Brown, Shaun William Davies

Research output: Contribution to journalArticlepeer-review

6 Scopus citations

Abstract

We consider a model of active asset management in which mutual fund managers exert unobservable effort to earn excess returns. Investors allocate capital to actively managed funds and passively managed products. In equilibrium, investors are indifferent between investing an additional dollar with an active manager or with a passively managed product. As passively managed products become more attractive to investors, active managers’ revenues from portfolio-management services fall, reducing their effort incentives. More-severe decreasing-returns-to-scale are also associated with reduced incentives and increased moral hazard. Performance-based fees and holdings-based data are all unlikely to mitigate moral hazard.

Original languageEnglish (US)
Pages (from-to)311-325
Number of pages15
JournalJournal of Financial Economics
Volume125
Issue number2
DOIs
StatePublished - Aug 2017

Keywords

  • Active management
  • Moral hazard
  • Mutual funds
  • Passive management

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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